A collection of often sceptical, always candid observations and insights on the US economy and large-cap equity markets. Readers have observed my style and perspective to be that "the emperor has no clothes," and that is reasonably accurate.
Postings reflect my philosophies and perspectives on economics, business and politics.

Wednesday, October 05, 2011

Regarding GE's China Avionics Deal

The potential for conflict between economic growth of US companies and US employment is perhaps no better exemplified than in the recent reports of GE setting up an avionics venture in China. Especially since GE's underperforming CEO, Jeff Immelt, the man ultimately responsible for this offshore business and job-creating venture, is also chairman of the president's special US job creation council.

Last week, the Wall Street Journal ran this piece about the venture,"During a factory tour in South Carolina, Jeffrey Immelt smiles and cuts me off after I ask another question about his new venture in China:"I'm done," says the chief executive of General Electric. "This was reviewed by the Commerce Department and the Defense Department."

If Mr. Immelt's response seems a bit edgy, it's probably because I raised a topic that has much of U.S. business on edge too: How to compete in China without giving away the store. And specific to General Electric: What's to keep GE's new avionics joint venture with China from transferring the best of U.S. technology abroad, empowering a new set of Chinese companies to challenge U.S. aircraft makers?China watchers are anxious about this venture. Avionics— the "brains" guiding navigation, communications and other operations on an airplane—are at the pinnacle of American know-how, where the U.S. is still highly competitive. It's also technology the Chinese military covets.GE says it has built protections into the venture, but the debate can get heated."To suggest that there are going to be firewalls that will stop this technology from going to the Chinese military is approaching laughable," says Rep. Randy Forbes (R., Va.), who sits on the House Armed Services Committee. "The fact that GE would say that is shocking."You could substitute many industrial companies for GE in this equation, because over the last 30 years most have struck their own difficult bargains with China's many state-owned companies. China is the world's fastest-growing major market, and in return for access the country frequently demands technology or other know-how. China then absorbs that technology and uses it to battle global competitors, selling products that are often heavily subsidized by China.That has happened in a range of industries, including autos, electronics and energy. Siemens now competes internationally against Chinese high-speed rail companies that sell products partly based on technology gleaned from an earlier joint venture with the German firm.The U.S. has restrictions on the export of certain technology that could threaten U.S. security, but it appears less equipped, or less organized, to contend with this broader challenge: what to do about the threat to many business sectors posed by China's state-sponsored industrial juggernaut. "We've been passive in deciding how to deal with China's aggressive industrial policies," says James Lewis, who worked on technology-transfer issues at the Commerce Department and is now at the Center for Strategic and International Studies. "U.S. companies are making the right decision from a business point of view, but it might not be the right decision for the country," Mr. Lewis adds."It's unclear whether anyone in the U.S. government took a look at the GE deal in terms of U.S. competitiveness—the future of the aviation industry 10 or 20 years out," says an executive who advises companies working in China. He worries that a heavily subsidized Chinese jet program, enhanced with U.S. avionics, could eventually clobber Boeing. "China has an incredible ability to distort markets, and we can't be reacting after the distortion has taken place."Clyde Prestowitz, a former U.S. trade negotiator who writes on global economics and business, says China is violating World Trade Organization rules that prohibit making technology transfer a condition of market access. "In a normal market the avionics would be done for that plane in the U.S. and we'd sell it to China," he argues.GE says it wasn't forced to give up its technology for market access. Instead, it sees this joint venture as a valuable piece of an existing global network of joint ventures and supplier relationships between the world's big aviation companies. "Technology is the heart and soul of our company," says Rick Kennedy, a GE spokesman. "Why would we give away our future?"In its China project, GE will develop a new generation of its avionics operating system with state-owned Aviation Industry Corp. of China, which supplies China's commercial and military aircraft industries. The business will be based in Shanghai and owned 50-50 by the two firms. GE says its half of the work load will chiefly be handled out of GE facilities in Florida, Michigan and Britain. And it expects that capturing new business through the joint venture will both boost exports from its U.S. operations and add jobs.The venture's first big customer: Commercial Aircraft Corp. of China, which is developing the C919 passenger jet to compete with Airbus and Boeing. The joint venture will also sell its avionics to aircraft makers globally. GE's current operating system is already on the Boeing 787.As for the Chinese military, GE says it has spent nearly three years developing a compliance program that it believes won't let the military near its technology. GE will run the compliance office and will vet all hiring. AVIC is forbidden from sharing information with its military business. And people who leave the venture must wait two years before they can take any Chinese military-related assignment.Still, China is an authoritarian country with a weak legal system. It is difficult to imagine that any technology deemed worthwhile in the GE/AVIC venture wouldn't somehow find its way onto the next-generation Chinese jet fighter. GE says that its system is specific to commercial use, not military. And if there were evidence that information had gotten to the Chinese generals, the joint venture would be shut down.Kathleen Palma, who handles trade compliance for GE Aviation, says GE determined that U.S. export licenses weren't required for the technology involved, but the company nonetheless briefed the Commerce Department and the Defense Technology Security Administration several times. She says the U.S. government appeared satisfied. A spokeswoman for DTSA said GE said it was "complying with all applicable laws." A spokesman for the Commerce Department referred questions back to GE.GE has manufacturing operations elsewhere in China, and it isn't alone in giving a lift to China's commercial jet program. Other U.S. companies have a piece of the action, including Honeywell, Hamilton Sundstrand, Rockwell Collins, Eaton and Parker Aerospace. Airbus has manufacturing operations in China. What is uncertain is whether these companies will remain part of China's aviation calculus once they are done being useful, and whether Chinese companies will supplant them. That transition has happened in other industries and is a mainstay of China's "indigenous innovation" industrial strategy, which is explicit about "metabolizing" foreign technology and making it China's own.GE says that if it hadn't linked with AVIC in a joint venture a competitor would have, which is very likely. Mr. Immelt, the CEO, says he'll take responsibility if the venture goes wrong. "It's on me," he says. "It's on me."But the reality is more complicated. When it comes to China and its ability to shake global industries, the ramifications of GE's decisions—and the decisions of many other American companies—are on everyone."

There are a number of interesting aspects to the GE avionics venture.

First, Immelt claims he is 'responsible' for the venture if it "goes wrong."

"It's on me" he was quoted as saying.

Well, GE's decade of shareholder value destruction has been "on him," too, it would seem, but that hasn't led Immelt to do anything to address the problem, has he? He's still being paid millions each year by the firm's equally-ineffectual board while continuing to run a lackluster, needlessly-diversified conglomerate.

Second, it's pretty clear that the place where most of the jobs will be created by this China-based venture will be....China! So much for Jeff demonstrating to other US executives how to create US jobs.

Third, Clyde Prestowitz' charge that GE's, and other major corporations' being forced by China to surrender technology as a term of operating in the country is a clear violation of international trade laws to which China has agreed to operate. Why isn't GE, the US government, or any other company pursuing these issues through appropriate international venues?

Fourth, if GE is a leader in this business, wouldn't it's refusal to cede its technology to the Chinese leave the latter with second-tier vendors whose new commercial aircraft would be inferior to those of Boeing and Airbus? Thus making GE's decision the very reason it will be problematic?

Fifth, who, with a brain, really believes that if GE ever discovers evidence of its technology inappropriately being transferred to the Chinese military complex, it will ever be able to do anything about it? The technology will be gone. The venture's closure will only hurt GE. And it's not likely the Chinese would let GE remove anything- money, people, equipment- if they didn't choose to. Just imagine the prospect of GE employees and property seized by Chinese, and subjected to interminable holding while the Chinese dared anyone, including the US government, to act to get them back.

Sixth, contrary to GE manager Rick Kennedy's contention that technology is the "heart and soul" of GE, so why would they compromise future returns, the answer is simple. Pressure to meet short term profit goals by a poorly-performing CEO- Immelt.

Seventh, there is clear evidence across several other product markets that the Chinese will take the technology they want, then kick the US venture to the curb and compete with those same companies internationally. Why does GE think it will be any different?

There are so many reasons to doubt the wisdom of this GE venture that its truly shocking that the US government has allowed it to go forward.

I had one thought while reading the Journal account of this disaster in the making. It was the Soviet Union's Nikita Kruschev chortling that Western capitalists would sell (to Communists) the rope with which they would eventually be hung, so hungry for profits, and shortsighted were they.

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About Me

A well-educated veteran of US corporate strategy positions & hedge fund management, as well as research, product development and project work in consulting, strategy and equity management. Academic background in marketing, strategy, statistics and economics.
Currently own Performance Research Associates, LLC, through which I am involved in proprietary equity and equity options investment management.